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Understanding the Cash Application Process

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As rewarding as it is to make a sale, it’s even more fulfilling to close out that sale when you receive a customer’s payment. The cash application process is the last–and some say most important–step in the order to cash (O2C) cycle. Cash application is the accurate matching of payments from customers to their open invoices and processing those payments so the funds can be used.

Cash Application Basics

The cash application process finalizes revenue, both in recognizing that goods or services were sold and in recording in the general ledger that payment was received. Without software and other tools of technology, cash application is completed by hand by a company’s controllers or accountants. They typically track three items: invoices (or orders), payments and remittances, which are particularly important if a customer makes a partial payment. 

Sounds simple enough, doesn’t it? But when you take a more detailed look, you see that the cash application process breaks down into many steps which take time and provide opportunities for error.

  1. Payment is received and hopefully there is a remittance with it. If not, then someone from the AR team needs to contact the customer.

  2. Remittance data is matched with the payment.

  3. The correct invoice is matched with the payment.

  4. Determine if the payment is complete or partial.

  5. Determine if the payment covers multiple invoices.

  6. Apply any discounts the customer should receive.

  7. Enter payment in your ERP or other accounting system.

  8. Post the payment.

Larger companies may have teams of cash application specialists who go through these steps all day long. The work gets done, but all that effort still represents a manually-driven process that’s tedious, time-consuming and inefficient. And when you have a growing list of customers, a manual process is simply not practical or sustainable.

How Did Cash Application Get Complicated?

In today’s modern B2B world, no one would argue the benefits of being able to take orders and receive payments electronically. But those improvements impact manual cash application–and not in a good way.

Now orders can come in through multiple sources and payments can be made with paper checks, through a lockbox service, wire transfers, ACH transfers, e-checks and credit cards. All these different payment transactions have to be compared to the orders that have come in through the various channels. 

To compound the problem, invoice matching is riddled with issues: sometimes the total amount due is broken into partial payments and paid at different times of the month; oftentimes one invoice is sent for multiple orders; electronic payments come through without any remittance advice; and some customers prefer you to access payments through their AP portals. The result of this tangled web can be too many open invoices, unapplied cash and payment discrepancies that must be resolved.

So it’s understandable that 41% of CFOs surveyed by Dun & Bradstreet report they would choose to automate the cash application process before any other part of the O2C cycle. 

How Does Cash Application Affect Cash Flow?

Payments that are received but still waiting to be applied are like an IOU. Until the money owed you is correctly applied, you can’t use it–for payroll, monthly bills, capital expenditures, inventory or growth. That’s why it’s critical that your cash application process is quick, efficient and accurate, giving you a predictable cash flow and reduced DSO.

If your funds are bottlenecked due to payment discrepancies or backlogged processing, you have little control over cash flow. Unapplied cash not only hurts cash flow but can possibly present you with tax or accounting compliance issues later on. You hope those kinds of issues are caught by an internal audit or at the end of the month during the close process allowing you to rectify them quickly. 

In a nutshell, the more streamlined and fast your cash application process is, the sooner you’ll be able to put your cash to work.  

Cash Application and Business Relationships

You may not realize how vital your accounts receivable process , including cash application, is to building strong relationships with your customers and other business concerns. When your cash application process is slow, your customers are affected negatively. Even though they’ve made payment, they may have to wait for the payment to be applied correctly in order to create their own cash flow forecasts and balance their accounts. Or they may make a duplicate payment that ties up more of their cash. 

Friction with customers can also be caused by a sluggish cash application process when they rely on credit from you. Quick, efficient matching of their payments to their outstanding invoices means they can tap into their business credit. If you’re lagging behind with cash application, you could be putting up an obstacle to their doing additional business with you.

And then there’s the issue of how error-prone manual cash application is. One inverted number or incorrect input can result in a payment being applied to the wrong invoice. Customers don’t enjoy having to contact you about an outstanding invoice that they know they’ve paid. Nor do they like to wait for you to make a correction and then process payment days after they’ve remitted it. 

Any of these scenarios leads to a poor customer experience. Conversely, you can build positive business relationships by having a streamlined cash application process that provides your customers with clarity and ease with respect to their accounting.

The Benefits of Automating the Cash Application Process

Because cash application is so labor-intensive and prone to error, it’s often the first step in the O2C cycle to be automated. Here are just a few of the benefits to be realized from eliminating manual processes with automation software:

  • Decrease in cash flow bottlenecks: Automation software tracks remittance data for quick invoice matching.
  • Fewer errors in payment processing: By replacing human data entry with automatic data transfer, errors are greatly reduced.
  • Overall reduction in costs: Time and money savings when cash application is fast and accurate.
  • Reduced DSO: Invoices are closed out faster with automation.
  • Improved analytics with complete remittance data: Reporting is more accurate and useful when you have all your data in real-time.
  • Greater visibility into the payment process: Automation gives you real-time financial data.
  • Scalability: With a “low” or “no touch” process, more transactions can be processed without increasing headcount.
  • Higher productivityYour AR professionals are free to focus on strategic tasks that contribute to growth.
  • Better customer relationships: Quick, accurate cash application enhances the customer experience.

Want to learn more about how automating your cash application process can help your business? Read this case study to find out how this business used automation to deal with a backlog of outstanding invoices and cut their DSO by 30%.

Payference is an AI-driven all-in-one cash management tool that streamlines the cash application process, increases cash flow and optimizes your working capital. We’re always ready to answer any questions you have or show you how our platform works.